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By Mark Melin

"In a deflationary environment, it is very hard for investors to hide," Cantor Fitzgerald's John Trammell said, who went on to note an investment that offers a family office a hedge to their beta exposure would be of interest.

The general benefit of managed futures investments are their lack of strategic correlation to the variables of economic strength. Most investments are based on the concept of an asset-stock, real estate, commodity-rising in value. Managed futures is a slightly different animal in that, due to the different market environment considerations, managed futures can deliver returns independent of the rising or falling value of assets. In other words, managed futures trend followers could perform positively in a deflationary environment so long as such an environment created consistent price trends.

"The general benefit of managed futures investments are their lack of strategic correlation to the variables of economic strength."

When developing an uncorrelated portfolio with managed futures, family offices might first understand the exposure they wish to mitigate and then recognize the trader's strategy and how it relates to market environment. For instance, Winton Capital, with a reported $28 billion under management, is a trend follower with 15 year track record and a compounded annual return of 16%, worst drawdown of 25.6%, and a downside deviation of 2.771. But what really matters is how the CTA performed during periods of economic difficulty. This is a period of time when most investments "tend to correlate to one," yet Winton performed positively in 2008 (up 21%).

It is important to understand why CTAs with strategies such as Winton performed in this fashion, then contrast this with other managed futures trading styles, and then use this knowledge to develop an uncorrelated investment portfolio.

Winton is a multi-algorithmic trend following CTA. Their particular strategy tends to experience positive market environments during periods of strong and consistent price trends. Often times when prices drop, such as the value of the S&P 500 or even commodities, the past tendency has been for the price drop to be strong and consistent, which tends to benefit a trend strategy. Contrast Winton and its correlation to the market environment of price persistence, to a trader such Emil van Essen. Van Essen, with a compounded annual return of 33%, worst drawdown of 36.21% and down deviation 4.65, has a different strategy that is correlated to the market environment of price dislocation and convergence back to the mean. Unlike Winton, van Essen is impervious to the general price direction of a market, but rather the relationship in price between related products and contract time frames.

Understanding how a CTA's strategy correlates to market environment is one key to building a financial hedge that is strategically correlated to a market environment un-hinged to economic strength is worthy of note, particularly relative to a deflationary, debt stressed economic environment.